The relief is available for qualifying incorporations and this overview gives brief details of the qualifying conditions.
To be eligible for incorporation relief a business must be a going concern and all assets of the business (apart from cash) must be transferred to the company. The amount paid to the individual by the company for the assets must be partly or wholly in the form of shares.
The relief is calculated by taking the total capital gains on the transfer of the assets and multiplying this total by the value of the shares received divided by the total consideration. This gives the amount of incorporation relief which is deducted from the total gains to leave any remaining gain arising on incorporation chargeable. Having a gain left in charge could perhaps be because the consideration provided by the company was only partly in shares.
Incorporation relief is a deferral relief, so the amount of the deferred gain is deducted from the base cost of the shares in the company. The deferred gain will therefore be chargeable when the shares are subsequently sold.
Incorporation relief is automatic and no formal claim is necessary. It is not possible for the individual to restrict incorporation relief in order to make sure the capital gains tax annual exemption is utilised. However, it is possible for the individual to take a specific amount of loan stock to generate a gain equal to the annual exemption.
Where a partnership or a sole trader's business is to be acquired by a company, it is common practice first to transfer the business to a newly formed company in consideration for shares, claiming incorporation relief. The shares are then the subject of a ‘share for share' acquisition by the ultimate purchasing company, so that tax on the capital gain is deferred.
The relief may also be used where a sole trader or partnership wishes to dispose of an asset standing at a substantial capital gain; the business may be incorporated, obtaining incorporation relief, so as to increase the base value of the asset for capital gains purposes before the newly incorporated company sells it.
Incorporation relief is automatic, if the qualifying conditions are met, but an individual can elect for the relief not to be applied. This will be a consideration for individuals who have not utilised their full business asset disposal relief limit, and particularly where they do not expect to be able to benefit from business asset disposal relief on a subsequent disposal of the shares in the company because they do not anticipate meeting the qualifying conditions at that later date.
Deferral of capital gains via reinvestmentWhy defer a gain?An individual’s net taxable income and chargeable gains for the tax year influence the rate of tax payable on their capital gains. See the Introduction to capital gains tax guidance note.Depending on the nature of the asset disposed of, this can result in the individual paying capital gains tax (CGT) at 20% or 28% in tax years where their taxable income and gains exceed the basic rate threshold (£37,700 for the 2021/22 and 2022/23 tax years) but only 10% or 18% on gains in years where their net income and gains are lower than that threshold. If a gain is covered by the annual exemption (£12,300 for the 2021/22 and 2022/23 tax years), no CGT is due. See the Introduction to capital gains tax guidance note.To optimise their CGT position, a taxpayer can reinvest the proceeds from the sale of an asset into the purchase of a qualifying asset and elect for the gain to be rolled into those replacement assets.When the replacement asset is subject to disposal, or possibly where the investment conditions are broken, the deferred gain falls back into charge to CGT. This may be some years after the original gain arose and in many cases, the timing of the gain falling into charge can be controlled by the individual.The deferral of gains can be achieved by five different routes:•reinvesting in business assets (see ‘Rollover relief for business assets’ below)•incorporation of a business (see ‘Incorporation relief’
Succession planning ― employee ownership trusts (EOTs)Where a controlling interest in a trading company is sold to an employee ownership trust (EOT) and the necessary qualifying conditions are met, there are capital gains tax reliefs for the seller and also the ability to pay bonuses free of income of up to £3,600 per year to employees. Therefore, using EOTs for succession planning can allow the owner of a business to pass on the company to the employees of the company for full market value without incurring a CGT charge. This method of sale can provide an alternative to external sales, management buy-outs or private equity backed buy-outs and may be more attractive given the reduction in the maximum amount of business asset disposal relief available from March 2020. This guidance note sets out the method of transferring to an EOT, the tax relief available and looks at some practical issues arising.Detailed commentary on EOTs can be found in the Employee trusts ― implications of disguised remuneration and where are we now? guidance note and in Simon’s Taxes C3.1915.HMRC guidance is set out at CG67800C onwards and the legislation is within TCGA 1992, ss 236H–236U.How does selling to an EOT work?In summary, a qualifying EOT is set up with a trustee and the shareholders in the trading company sell more than 50% of the current share capital to the EOT under a share purchase agreement for
Company tax planningIn addition to considering the tax issues for shareholder, it may be necessary to do some planning for the business to be floated, including:•ensuring that all assets necessary to the running of the business are owed by the company, including intellectual property assets (it is not always clear who actually owns these, particularly where the company has grown over a long time) and real estate•separating out assets or trade which are not necessary for the business that is to be floated•incorporation of the business, where it is not already in a companyThis planning should be done as early as possible, to minimise any associated tax costs.Transfer of assets to the company by shareholdersWhere assets used by the company are owned by shareholders, either as a deliberate policy where the premises are owned by a shareholder as part of tax planning, or accidentally such as where intellectual property developed by a shareholder is used by the company without formal licence or payment of royalties, it will usually be necessary to transfer the assets to the company as the company will usually need to be floated owning all the assets necessary to the business for a flotation to be successful. Investors are rarely keen to
Capital gains of traders ― overviewCapital gains of traders ― further guidanceLinks to guidance note(s)Incorporation. On incorporation of their business, a sole trader (or the partners in a partnership) will be treated as disposing of the assets transferred to the company. Where beneficial, it may be possible to defer any chargeable gains using incorporation relief, which defers any chargeable gains against the base cost of the company shares, or gift relief, which defers the gains against the base cost of the assets in the companyIncorporation ― introduction and procedureCapital gains tax implications
Business asset gift relief ― restrictionsWhere assets are gifted or subject to disposal at undervalue, the legislation treats the disposal as having taken place for market value proceeds. The transferee’s base cost is the deemed proceeds (ie market value) at the date of the gift, no matter the actual consideration paid. To mitigate the transferor’s cash flow problem where they have capital gains tax (CGT) to pay but may not have received any consideration, business asset gift relief (also known as gift relief or hold-over relief) can be claimed on the gift of qualifying business assets. Gift relief operates to defer the gain by rolling over the capital gain against the base cost of the asset in the hands of the transferee. Essentially, the relief ensures the transferor’s capital gain is passed to the transferee.The conditions for claiming business asset gift relief and the mechanics of a claim for full relief are shown in the Business asset gift relief guidance note. It is recommended to read that guidance note before continuing.This guidance note considers occasions where either the amount of gift relief is restricted or where the amount of the gain qualifying for gift relief is restricted. In either of these cases, this means a proportion of the gain remains chargeable following the gift relief claim, therefore this guidance note also considers the interaction of gift relief with other CGT reliefs.The restrictions depend on the type of asset and are summarised in an interactive flowchart. Alternatively, for a static
Other capital gains business asset reliefsThis note deals with the following types of business asset reliefs:•rollover relief on replacement of business assets•incorporation relief•capital gains tax (CGT) deferral relief under the enterprise investment scheme (EIS)•CGT reliefs on company reconstructions•losses on loans to tradersSo-called ‘business’ hold-over and business asset disposal relief (formerly entrepreneurs’ relief), are dealt with in the Hold-over relief and Business asset disposal relief (entrepreneurs’ relief) ― trusts guidance notes.Except where noted otherwise, these reliefs are available both to personal representatives and to trustees. For brevity, this note omits any further reference to personal representatives except where such reliefs specifically do not apply or are not available to them.Rollover relief on replacement of business assetsRollover relief enables the gain arising on the disposal of certain types of business assets to be deferred if other qualifying assets are acquired within the period commencing one year before and ending three years after the date of the disposal. HMRC may extend these time limits in certain cases. Relief will be restricted if the asset disposed of has not been used for business purposes throughout the period of ownership.The relief must be claimed within four years of the end of the tax year in which the disposal of the assets, or acquisition of the new assets (whichever occurs later) takes place. A provisional claim can be made if there is a clear intention to obtain the relief, however if the tax deferred ultimately falls due because the conditions
Year-end tax planning for individuals ― overviewTaxpayers may wish to consider basic tax planning arrangements in order to reduce the overall tax burden for them or their family.This is normally considered at the end of the tax year, either to reduce the liability for that tax year or to put arrangements in place that will reduce the liability in future tax years.Summary of guidance notes on personal tax year-end planningThe guidance notes covering year-end planning are split up by tax.Income taxSummaryGuidance noteThis guidance note first examines the various income tax allowances and lower rate bands that should be considered and then the various strategies that might be appropriate, depending on the family circumstances. It also looks at the relevant anti-avoidance provisions and actions to consider before the end of the tax yearUtilising allowances and lower rate bandsTax efficient investments provide the investor with relief from one or more taxes for the current tax year, or are exempt from income tax and / or capital gains tax. Some investments have both attributes. This guidance note considers common tax efficient investments that might be appropriate, including the various individual savings accounts, venture capital schemes and pension contributions. It also looks at actions to consider before the end of the tax yearTax efficient investmentsCapital gains
Offshore funds ― opaque fundsAn outline of the regime applying to offshore funds, including a description of the various types of fund, is discussed in the Offshore funds guidance note. You are advised to read that guidance note first. That guidance note also explains what is meant by a ‘reporting’ and a ‘non-reporting’ fund.Reporting funds can be divided into ‘opaque’ funds (also known as non-transparent funds), where investors are regarded as owning units in the fund rather than as owning precise fractions of the underlying assets, and ‘transparent’ funds, where the investor has a share of the underlying fund assets. The fund manager should be able to tell the taxpayer whether their fund is opaque or transparent for tax purposes.This guidance note considers the tax treatment of opaque funds, both reporting and non-reporting. For the tax treatment of transparent funds, see the Offshore funds ― transparent funds guidance note.A list of whether an entity is regarded as transparent or opaque for UK tax can be found in INTM180030.This list may not be up to date in each case, and it is possible that HMRC’s view may now be different. If in doubt, clarification can be sought using the contact details in INTM180020.The taxation of offshore funds is very complex. This note is only an outline of the topic, it may be necessary to take specialist advice. In particular, there are further complexities where one offshore fund invests in another, has an
Incorporation ― introduction and procedureMany businesses commence in an unincorporated form as a sole trade or a partnership. Start-ups benefit from the simplicity and low administration provided by a sole trader structure in particular. Relief for opening years’ losses are also significantly more favourable for sole traders and new partners. Even once a business has become established, operating in an unincorporated form has benefits and may continue to suit the proprietor(s) indefinitely.However, there is a distinct path for growing businesses whereby incorporation becomes a natural step.Key reasons to incorporateThe key reasons in favour of incorporation tend to be:•limited liability allowing the mitigation of risks associated with expansion•tax mitigation•flexibility over income in respect of the timing and form of remuneration•a reduced perception of the administrative burden due to familiarity with running a business•a greater ease of attracting external investment•prestige value•certain tax reliefs are only available to companies, see the Calculating the tax benefits of incorporation guidance noteLimited liability means that the members of a company (ie the shareholders) cannot normally be held liable for the actions or debts of a company, though this is sometimes eroded by third parties such as banks, etc, who often require personal guarantees from the directors / shareholders in respect of the company’s overdraft or other borrowings. Limited liability can also be lost when the directors continue to trade when the company is insolvent. However, the protection of limited liability nonetheless remains extremely valuable. Limited liability
Deferring the property gain ― individualsThere are various capital gains tax reliefs which an individual can utilise to defer the capital gain on a property disposal until a later time, thereby postponing the tax bill. These are discussed below.Categorising the gainThe first step in deciding what deferral reliefs may be appropriate to the taxpayer’s situation is to decide whether the gain on property relates to the disposal of a business asset or a non-business asset. Where the taxpayer disposes of a business asset, a wider variety of reliefs are available.Non-business assetsA property business is often not considered to be a trade as the properties are held for investment purposes. If the property business were a trade, the sale of property would be a sale of stock and would therefore be chargeable to income tax. Whether the letting of property can amount to a trade is a question of fact. This is discussed in the Transactions in UK land ― individuals and Application of the badges of trade guidance notes.On this basis, the sale of a property used for the purposes of letting is normally classed as a non-business asset.Note that if the property has been used as the individual’s only or main residence at any point during the period of ownership, principal private residence (PPR) relief may be available to exempt all or part of the gain. See the Principal private residence relief ― basic principles guidance note.Business assetsAs far as land is concerned, generally the following can be
Discover our 11 Tax Guidance on Incorporation relief
Speed up all aspects of your legal work with tools that help you to work faster and smarter. Win cases, close deals and grow your business–all whilst saving time and reducing risk.
**Free trials are only available to individuals based in the UK. We may terminate this trial at any time or decide not to give a trial, for any reason.
""You do get what you pay for, absolutely, and I admit that I breathed a huge sigh of relief to have Tolley back.""
Access all documents on Incorporation relief